Those new to their careers may look at the Income Tax Brackets and declare "Good Grief! I am in the 25 percent tax bracket! The government is robbing me blind!" But, what does it all mean? Is the government taking 25 percent of all your income in taxes?
First, we need to determine what is taxable income. The beginning point is found on the first page of your 1040 Form. There are seventeen categories of income starting with wages, salaries and tips and ending with other income. However, not all income is considered income. For example, not all Social Security is taxable. Also, adjustments to income are deductions are not shown on Schedule A. Some of these include educator expenses, student loan interest deductions and alimony. When we apply these adjustments to the income, we arrive at Adjusted Gross Income which is shown on lines 37 and 38 of the form.
Next, we have to take exemptions for you and your spouse. Then we have to account for itemized deductions which are found either on Schedule A or the Standard Deduction found on page 2 of the 1040. The greater of these two are taken. Finally, we have to take further deductions for your exemptions which include any dependent children. Then, we can determine your taxable income which is found on line 43.
Federal Income Tax is progressive in nature; as our income increases so does the tax rate. The Income Tax Brackets for 2011 have six tax brackets: 10,15,25,28 and 33 percent. Adding to the confusion is that these tax brackets vary by status. The break points (or when you shift to a higher bracket) are different for single, married filing jointly, married filing separately, head of households and estates. The break points for married filing jointly are $16,760, $68,000, $137,300, $209, 250 and $373, 650.
For example, Taxpayer A has $20,000 in taxable income. The tax bracket formula says that he pays $1,675 or 10 percent of $16, 750 plus 15 percent of the excess of the amount over $16, 750. Doing the math yields $1,675 + $489 or $2,163. Note that if we decide the $2,163 tax by the $$20,000 in taxable income, the overall tax rate is 10.8 percent.
What about Taxpayer B, who is in the 25 percent bracket? He got there by having taxable income of $100,000. His formula is $9,353 plus 25 percent of the excess over $68,000. Again, doing the math yields $9,353 + $8,000 or $17, 353. Ouch! If we divide the $17,353 tax by $100,000 in taxable income, the overall tax rate is 17.35. Of course, however, none of this takes into account the other income taxes like state income taxes.
If you need assistance with your tax preparation or tax planning, including understanding how to reduce tax liabilities, contact us. We can help. Call us at 888-727-8796 or email firstname.lastname@example.org.